Atwood Oceanics: Simple, Well-Managed and Cheap

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Feb 26, 2015

Atwood Oceanics (NYSE:ATW) is a very simple business. It rents offshore drilling rigs and fleet around the world to companies like Shell (RDSA, Financial), Chevron (CVX, Financial) and Apache (APA, Financial). It divides its fleet into the following categories: Ultra-Deepwater Rigs, with 6 available rigs, Deepwater Semisubmersibles, with 3 rigs, and Jackups, with 5 in total.

On Feb. 2 and Feb. 5, 2015, Atwood reported its current fleet status and quarterly reports, respectively. In these documents, we can find good news for investors. The percentage of available operating days committed for the years 2015, 2016 and 2017 are 96, 58 and 17% respectively. Naturally, day rates are subject to change due to cost escalations and FX provisions in the contract. The average day rate committed is around $480,000. With these numbers, I discounted the figures to reach the present value that these represent.

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For the last 10 years, the average and median net profit margin for Atwood has been 34.2 and 34.5%, respectively. With this in mind, the approximate value of the contracts per share at the moment is around $10.3.

Backlog is the amount of unfinished work or incomplete customer orders that have already been received. The current amount of backlog is very large, at $2.7 billion. This indicates that Atwood is currently experiencing high demand for its services and displays an important profit potential for the near future. With only 15 rigs as their total capacity, we can assume that most of these will be fully used.

Opportunity

Here is an introduction that Roger Lowenstein made for the sixth edition of %3Cem%3ESecurity+Analysis%3C%2Fem%3E:

"The competition for such values is fiercer in the United States, but they can be found, especially, again, when some broader trend punishes an entire sector of the market. In 2001, for instance, energy stocks were cheap (as was the price of oil). Graham and Dodd would not have advised speculating on the price of oil-which is dependent on myriad uncertain factors from OPEC to the growth rate of China's economy to the weather. But because the industry was depressed, drilling companies were selling for less than the value of their equipment… Investors were getting the assets at a huge discount. Though the subsequent oil price rise made these stocks home runs, the key point is that the investments weren't dependent on the oil price. Graham and Dodd investors bought into these stocks with a substantial margin of safety."

And here are some comments from Jeremy+Grantham on oil:

"As with Alice's Red Queen, if you pause for breath in fracking you go backwards: more wells must be drilled all the time to even stay still as the wall of rapidly depleting wells builds up behind you. Nothing remotely like this has ever been experienced before so drawing wrong conclusions, as if the traditional data applied, is particularly easy.

"After supply and demand come into balance, the price initially is likely to rise slowly, held in check by the increasing amounts of U.S. fracking oil that can be profitably produced at each new higher price level. It is this rapid response rate that will make the frackers the key marginal suppliers. This is a sensitive and, I believe, unknowable equation as to precise timing, but this phase will likely end only when fracking production, even at much higher prices, tops out, as it most likely will in the next five years. After that, I believe the equation will revert to the relatively more stable and more knowable one of the 2011 to 2013 era, in which the price of oil will be the full cost of finding and developing incremental traditional oil, which by then is likely to be over $100 a barrel."

While I will not make a forecast on when the oil price will rise, the facts are that I believe it will be based on capacity. But the most attractive part of this is, just as Lowenstein mentioned, this opportunity is does not depend on the oil price but more on assets. The fact that nearly 100% of total capacity for 2015 is already committed is just a bonus.

Risks

One important threat for the company is the relationship it has with oil prices, which is the reason why its price dropped significantly. If oil prices are to decline significantly before they reach a new equilibrium, the impression among analysts and investors is likely to be detrimental. (In spite of 2015 full-year earnings already committed.)

A company-specific risk could be a requested delay in the delivery of two newly built ships due the retreat of a customer affected the company recently. While this was made to avoid having idle equipment, investors might perceive the retreat of customers as an important threat, an important factor for 2016 and subsequent years. Capex and production reductions by important clients could also dampen ATW results for the near future.

Valuation

With many ways to skin a cat, here are some relevant metrics that can help us reach a conservative value for the company. Not only has the company grown by double digits in nearly all of these variables, but Atwood has also done it while taking care of its liquidity and asset base. The price at the time of writing is $33.50.

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I chose to value Atwood ATW conservatively with two methods: Net Reproduction Value and Price/Tangible and EV/EBIT multiples.

Net Reproduction Value is obtained by adjusting the assets in the balance sheets and then adding up a percentage of operating costs times sales, plus the average R&D value for the past three years times a given percentage. Then we subtract the Non-interest bearing debt and the excess cash.

In a more straight way the formula is as follows: Adjusted assets + 5-year Average SG&A as % of sales * (Last full year sales) + R&D value - (total liabilities - (Notes payable - ST debt - current portion of LT debt - LT debt)) - Excess Cash (generally 2% of sales)

I adjusted the PP&E, which is the most important driver of Atwood's revenue and ruled out 40% of the stated value to create a stressed scenario. With this in mind, and applying the calculation, the Net Reproduction Value turns out to be $42.4 per share, implying a 26% upside from the current price. This could be perhaps too conservative, but I prefer to err on that side than to be overly optimistic.

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Source: Company's SEC filings and own adjustments.

Another method that can be used is multiples. In scenarios like this, where there is some uncertainty given the oil prices turmoil, I prefer to stick with assets as a valuation method. To take into account some earnings, I will also use EV/EBIT.

The current P/B ratio is .86x, which is the historical low. The five-year median is 1.4x, while the five-year maximum value has been 1.67x. To be conservative, let's say the fair multiple should be 1.15x. With that in mind, the current 39.3 BV per share times 1.15x, the estimated fair value is $45.2, implying a 34% upside.

In terms of EV/EBIT, and with 96% of 2015 already committed, we can play around with the numbers. If we imply a 5% increase in revenues to $1,235 million, and an operating margin of 48.7% (which is lower than the 10 year average of 49.3%), and we multiply by a conservative value of 7.5x, we obtain $4,512M as an estimate value of the operating segment. By adding up the available cash and subtracting total debt, we arrive at an estimate value of $43.9. Just to put this into perspective, the median EV/EBIT multiple for the last 10 years has been 9.8x, while the minimum has been 6x.

These estimates are very conservative; however, market sentiment could lead to lower prices in the short run. Guidance and communication from the company with regard to upcoming years' results will play a fundamental role.

Conclusion

From a very conservative stance, I think the upside for Atwood is likely to range from 25-35%, while the downside is very likely to be limited at around 10% on a pessimistic scenario, however, I believe the assets and their commitment rate offer a great protection for investors.